Increasing my Long-only equity portfolio in size but need a hedge in event of market crash : any ideas ?

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15th Jun '18 by weycome45

21 comments 6622 reads

I have a consistently profitable track record in trading over weeks and months etc along the lines of hedgefunds and don't touch day trading whatsoever but I need to protect myself if the market suddenly does a nosedive of say 2000 points through macro-economic reasons or geo-political risk factors etc. I don't want to erode or nullify profits on existing long positions by doing this hedge so am I asking the impossible or does someone have a proven strategy ?

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Weycome45

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21 comments

weycome45

15th Jun '18

Good , interesting and entertaining commments ! Now does anybody else want to have a go at the Billion dollar question ?

Gromley

15th Jun '18

It is not proven (although I have enough surrounding evidence to give me a personal degree of confidence) but I wrote my thoughts here :

https://www.stockopedia.com/co...

It is my belief that a diversified portfolio of Low Stock Rank stocks should consistently underperform the market (and therefore any consistently market beating portfolio), but it is neither easy nor risk free.

However, when you say :

I have a consistently profitable track record in trading over weeks and months

I have less confidence. I you are actually trading over such timescales, then you may be much more volatile than any hedge I can think of, I which case the answer would be no and that I doubt that what you are looking for exists.

weycome45

15th Jun '18

LOW stockrank ? Surely you mean high stockrank ? If you don't please expand on why the stocks have to be LSR as I"m lost .

Nick Ray

15th Jun '18

You asked for a hedge. He pointed you at a strategy for a hedge.

DaviStoVest

15th Jun '18

Why not just buy one of the short-tracker ETFs?

StudyingHard

15th Jun '18

Wouldn't gold still be the most reliable hedge? I'm not a huge fan of gold myself. But so far so good, in terms of stock market crashes and gold, unless I'm mistaken?

Gold prices are historically fairly high these days, true enough. But then again, the economy has grown as well and with it the purchasing power of a limited resource and thus the natural price level of it.

I'd look up some academic research on precious metals as hedges. Certainly don't buy it on my thoughts alone. But that's the closest thing I can think of as a universal hedge to panic.

That or of course, bitcoin (Disclaimer: That's a joke, please don't downvote me into oblivion).

donald pond

15th Jun '18

Gold miners are also a relative hedge, or you could look at something like Burford Capital (LON:BUR), which in theory is uncorrelated to market returns, though in practice it may drop if holders are forced to liquidate to cover other positions. If you are willing to accept a reduction in your possible returns, you could also consider infrastructure funds: there are lots of these and they are no longer at the premiums they were at a year or two ago (eg £HICL).

pka

15th Jun '18

"you could also consider infrastructure funds: there are lots of these and they are no longer at the premiums they were at a year or two ago (eg £HICL)".

People considering investing in infrastructure funds should bear in mind the reason why they are on lower premiums than a year ago or on discounts, and that's because of fears of what a Labour government under Corbyn and McDonnell might do to them:

http://citywire.co.uk/investment-trust-insider/news/labour-threat-to-seize-pfi-assets-hits-infrastructure-funds/a1053070

The falls in their share prices might mean they are better value now than they were a yearago and they may be useful as a hedge against a bear market in conventional stocks, but there is a significant political risk to their future share prices if Labour should win the next election.

mmarkkj777

15th Jun '18

I agree with Davistovest. Use stop losses on all your stocks and then also buy a short Tacker Fund. I have not bought a uk market short fund, but I’ve bought an American one. fidelity I think were the managers. I did it Due to a certain election that was taking place but in hindsight I needn’t have bothered.

RadioactiveMan

16th Jun '18

Hedges seem somewhat pointless to me as you are compromising your returns by investing in an asset that should do badly when your personal preferences are doing well. For example, gold is the traditional hedge as it has psychological importance as a currency but over a long enough period of time gold has returned a fraction of what stock markets has as it does not generate income. Hedge funds have also performed worse than the stock market as Warren Buffett showed with his famous bet against a hedge fund manager even though the wager was placed before the 2008 crash.

A short term solution would be to use a short tracker if you didn't want to move to cash for any reason but it sounds like you're after a long term hedge. Property and gold are probably the best two options if you are committed to this strategy. Property holds a special place in the British public's minds and it is where a lot of people run to when they lack trust in the markets. There are risks with any investment and you back yourself to outperform the market with investments then you need to use your intuition to reduce you exposure and move to cash as you suspect there may be trouble ahead. There is risk with this strategy but that is ultimately what leads to superior gains.

iwright7

16th Jun '18

I don't think there is a perfect hedge, only measures that will reduce the level of loss in a downturn.

Its worth reading carefully Nick, Howard and Gromley's comments on Ed's excellent 5 Year Stockrank Review. Note in particular the JP Morgan part on "Cycle Investing" and owning Super Stock type companies going into a recession and of buying bombed out Mid range V/Value Traps coming out of recession. Neatly makes the case that no one one system works all the time. I have cut and pasted their graphics and incisive comments into a Bear Market Word file; least I forget! Ian

https://www.stockopedia.com/co...

jjis

16th Jun '18

Hedging normally has a cost attached to it, like an insurance premium. For example you could buy Puts on the FTSE (which may or may not be a good hedge for your portfolio) and you would have to pay a premium for this. If the market then goes up and the options expire worthless this will have cost you some of your returns.

You said "I don't want to erode or nullify profits on existing long positions by doing this..." & "so am I asking the impossible"

I think you have answered your own question right there.

mmarkkj777

16th Jun '18

Property and gold, to my mind, are not really a hedge, more diversification. In a true ecomic slump surely property prices are also depressed, albeit not directly connected to share prices. Short trackers are a more direct and counterbalanced hedge, but then you are spending money that will work against your gains, as has already been said.
one last point. I wouldn’t compare your performance to hedge funds and investment houses over week and months, only years. The private investor has some advantages over the professionals. Don’t get me wrong get me wrong, it’s great to do well over short periods ( if it’s on the way to doing well over longer periods). Analyse what you are doing well ( and not so well ), record it and review it regularly. It will help massively in the longer term.

Rusty2

16th Jun '18

I don't agree property is a good hedge, certainly in the last crash property prices also fell. Gold can be good, depends why there is a problem, if UK only then the £ will fall so gold value will go up as price is based in US$s, but so is oil, you could short the £. In times of war then gold is a safe haven. You could look at defensive shares, such as supermarkets, ultilities and drink companies, these hold up in a recession. Gold you can invest directly or in miners or companies such as H & T (LON:HAT) which benefit when the gold price goes up. Hedging is for short term. Shorting indexes would be something I do if markets are falling, it's easier than selling everything and then buying them back again.

Howard Adams

16th Jun '18

Hi

A very interesting thread.

I think my hedge is a behavioral one.

I have pre-agreed with myself that if a sharp market turn occurs I will, if need be slice 50% off all holdings. If the fall continues I will exit 100%. I will do this rapidly and without analysis.

How do I justify this to myself - costs, loss of long-nurtured nicely compounding holdings, fear of missing out and fearful you have mistaken the signals and its not a downturn?

Because it seems to me from my experiences that you cannot be certain how long a downturn will last.

But most importantly I have found that once my assessment develops that it is appropriate to begin to go back into the market. The stocks which now fit my buying criteria are very rarely the stocks I was holding prior to the downturn event. In effect my portfolio is reconfigured. I perceive that what has now occurred is that I am now buying stocks more suited to the changed market conditions, than were my previous holdings.

As iwright7 in post 12, above, points out, what I seem to be doing is following a pattern explained by the JP Morgan model of investing versus cycles. Which is posted by Howard Marx in post 6 of this thread https://www.stockopedia.com/content/the-stockranks-five-years-of-market-beating-returns-and-ten-essential-insights-374564/?comment=19#19

I did not necessarily design this strategy, rather, it evolved over a few downturns. It seems to have worked thus far and seems to fit with my own mind set. I am certainly not advocating a trying to ,time the market approach'. I am a 'time In market' enthusiast.

Rather, I am suggesting that a rapid flight to cash de-risks things. But importantly by executing such a procedure I am forced to appraise the market completely afresh after the change and thus look at stocks afresh. Much as the JP Morgan model suggests.

Clearly such a process will not be palatable to many, but it might resonate with one or two.

It has taken me several years to embrace such a mindset, but I am a little bit more confident about facing market turbulence than I used to be.

I freely admit, it is not a clever approach in any way, rather it is a behavioral approach. It takes emotional effort to embrace it and even more to execute it - ditching a portfolio you have carefully nurtured is unpleasant. But it does catalyse a period of renewal or 'creative destruction', which thus far I have found to be quite rewarding.

Regards
Howard

jonesj

16th Jun '18

How do you define a sharp market turn ?

How do you distinguish between a 10~15% intra year dip, which is a buying opportunity & the beginnings of a >40% drop ? I don't see this as easy.

As Charlie Munger says, why should people expect it to be easy ?

mmarkkj777

18th Jun '18

Hi Howard, on your last point, on the contrary, I think its a very clever approach. But at what stage in the dip will you sense that its a full downturn/crash?

Warren Buffet has always maintained its impossible to time the market and its "time in the market" that wins in the long term. But he's a crafty old buzzard and I've heard he is sitting on over $100B in cash, because there is nothing in market at the moments that's a big enough bargain for him (which suggests the US market is over-valued). Could he be holding back to buy in an upturn I wonder?

Chris Brown

20th Jun '18

Anyone thinking of using a short/inverse ETF or a leveraged ETF really needs to heed the warnings in this article:
https://www.morningstar.com/articles/271892/warning-leveraged-and-inverse-etfs-kill-portfolios.html

I've been tempted by them in the past but this was enough to put me off. The longer you hold them the more dangerous they are, and it becomes almost certain that you'll lose money.

Zoiberg

20th Jun '18

http://www.kitco.com/news/2014-10-13/2008-Financial-Crisis-Set-Stage-For-Gold-Rally.html

In the 2008 crash gold initially fell pretty much in line with the stock market.

Zoiberg

20th Jun '18

As for short ETFs, it's quite easy to see what they do by setting up a spreadsheet of an index that oscillates daily by x%. Start with 20% as this makes the fractions easy to understand. All short and all leveraged ETFs gradually lose money in a sideways trading market although that hasn't stopped me from buying a 2x inverse ETF while Trump engages in Trade Wars .

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Increasing my Long-only equity portfolio in size but need a hedge in event of market crash : any ideas ?

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Weycome45

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